Extenality

Abhishek
April 2, 2023

Q1)A farmer cultivates rice adjacent to a dairy farm. Each farmer behaves
as a competitive firm. The farmer benefits from the free waste generated by
cows of the dairy farm and the money value of the benefit to the rice farmers
from the cow waste is 1000 from each cow. Dairy farm has a marginal cost
MC = 1000 + 5Q, where Q is the number of cows. The dairy farmer can sell
the milk yielded from each cow at 4000.The waste from each cow is being
disposed- off freely by the dairy farmer.
(i) Find the privately optimal number of cows that the dairy farmer will
maintain.
(ii) Find the socially optimal number of cows that the dairy farmer should
maintain.
(iii)Suggest two ways in which the socially optimal number of cows can be
maintained in this economy.

Q2)A beekeeper chooses the number of hives ’H’ to keep.Each hive pro-
duces one kg of hive which sells at a price of Rs 65 per kg.The marginal cost
of holding H hives is :M C = 20 + 8H . The hives are located next to apple
orchard. The apple orchard benefits ( without paying) from the bees because
bees pollinate the trees and bees from one hive pollinate one acre of apple
trees. The cost of artificial pollination is Rs 24 per acre of apple tree.
1)How many hives ’H’ the beekeeper will maintain.
2)Is this the economically efficient number of beehives? Explain?
3)What changes would lead to socially efficient outcome.
4) How much subsidy should be given to the beekeeper to induce him to
produce socially efficient number of beehives?

Q3)Consider a firm that produces dynamite ’d’ and a nearby firm that

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produces tomatoes ’t’. The cost of production of dynamite is:
T Cd (d, n) = 12 d2 + (n − 2)2
where ’d’ is the amount of dynamite produced and ’n’ is the intensity of ni-
trogen used in the production od dynamite.The side product associated with
the use of nitrogen is ammonia - a fertilizer that is released into the air.Such
fertilizers promote the growth of tomatoes making the production on the firm
cheaper.. In particular higher the intensity ’n’ the lower the farmers cost:
T Ct (t, n) = 21 t2 + 2t − nt
The price of tomatoes and dynamite arePt = Pd = 1
1) Find the amount od dynamite ’d’ and intensity ’n’ that maximises the
profit of the dynamite manufacturer.What is the maximal level of profit?
2)Given the intensity ’n’ in )1) find the optimum levl of tomatoes production
’t’ and profit of the farmer.
3) Find the joint profit of the dynamite manufacturer and the farmer.
4)Economists say that positive externality is associated with too little ac-
tivity, compared to the efficient outcome. Are your findings in this question
confirm this statement?

Q4)The production of good X confers external benefit on the producer

of Y through a reduction in the latter’s cost of production. Specifically :
2 2
C(x) = x4 and C(y) = y2 − 20x are the total cost function of goods x and y
respectively. x and y are sold in competitive market at Px = 30 and Py = 90
respectively.
1) Find the amount of x and y produced and their profits if each producer
produces independently.
2)Find the socially optimum level of x and y.
3)Find the total profit at the socially optimum level of x and y.
4) Find the optimum amount of subsidy per unit that the producer of x must
be given in order to induce him to produce the socially optimum output.

Q5)3.A) A farmer cultivates rice adjacent to a dairy farm. Each farmer

behaves as a competitive firm. The farmer benefits from the free waste gen-
erated by cows of the dairy farm and the money value of the benefit to the
rice farmers from the cow waste is Rs1000 from each cow. Dairy farm has a
marginal cost M C = 1000 + 5Q, where Q is the number of cows. The dairy
farmer can sell the milk yielded from each cow at Rs4000.The waste from
each cow is being disposed- off freely by the dairy farmer.
(i) Find the privately optimal number of cows that the dairy farmer will

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maintain.
(ii) Find the socially optimal number of cows that the dairy farmer should
maintain.
(iii)Suggest two ways in which the socially optimal number of cows can be
maintained in this economy

Q6) Two friends A and B, share a room. Each of them has a liking for
the private consumption good (money), but B does not like the music that
A plays. The utility functions of A and B are as follows: UA (X, M ) = XM
and UB (X, M ) = X − M , where X represents the consumption of the private
good (money) and M represents that the number of hours that the music is
played per day. Assume that playing music is cost less for A and there are
24 hours a day.
1) Without any prior information about the property rights to play the mu-
sic, is it safe to conclude that an allocation of Rs 50 worth of money to each
of the consumer and 6 hours of music everyday is a Pareto efficient alloca-
tion? Why or why not ?
2) If not, then can you demonstrate how allocation of a ”right to silence ” to
B can make both A and B better of than (1)
3) Can any other mechanism be used to achieve an allocation as in (2) ? If
yes give an example.

Q7)A lake is open for all fishermen. The cost of taking a fishing boat out
to fish is constant and equal to C . If B boats are taken out, f(B) fish will be
caught in all. f (B) > 0, f ′ (B) < 0atallB > 0. Also C > 0 , and the price of
fish (P > 0) is unaffected by the fish catch of these fishermen.
1) Write the condition for the equilibrium number of fishing boats taken out
on the lake. Is the condition for the efficient number of boats is the same?
Explain.
2) If B = 100B .5 , C = 10 andPF = 2, calculate the equilibrium number
of boats, efficient number of boats and the amount of tax that needs to be
imposed on each boat so that the efficient number of boats are taken out on
the lake.

Q8) The demand for energy efficient appliances is given as:

P = 100
Q
The market for energy efficient appliances are perfectly competitive. The
marginal(private) cost of production of energy efficient appliances is given

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by MC = Q.By reducing demand on the electricity network energy efficient
appliances generate an external marginal benefit according to MEB = EQ
where E is some constant.
1) What is the equilibrium level of energy efficient appliances traded in pri-
vate market.
2)If the socially optimal level of energy efficient appliances is 20, find the
value of ’E’.
3)If the government subsidized the production of energy efficient appliances
by Rs S per unit, what level of subsidy would induce the socially optimum
level of production?

Social welfare and Public Goods

Q1) Arun and Barun are deciding whether or not to buy a TV for a room
they share ( if bought, it would be a public good for them). Aruns utility
function is given by UA = (1 + G)MA and Barun’s by UB = (3 + G)MB ,
whereMA andMB are the amount they spend on their private consumption
respectively.G = 1if the TV is bought, and G = 0 if it is not bought. Both
of them have Rs 60000 each to spend on the public good and the private
consumption and the TV costs Rs 50000. Is it pareto optimal for them to
buy Tv, explain?

Q2)In an economy the utility possibility frontier is given by UA + UB =

8100.
Draw a diagram and explain in which case(s) will social welfare, W , be max-
imized necessarily at an interior point.
1) W = max(UA , UB )
2)W = aUA + bUB , a, b > 0
3) W= UA UB

Q3)In a town of 20,000 residents ’security’ is a public good. It costs

Rs500 to provide a unit of security. The marginal benefit MB of a unit of
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’security’ to each resident is given by MB = (1+G where G units of ’security’
are provided. What is the pareto efficient amount of ’security’ for this town.

Q4)Suppose two individuals A and B have the following preferences over

private good (x) and public good (g):

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 √ √
UA = xA + g and UB = xB + g and the cost of providing public good is
C(g) =.5g Show that a unique amount of the public good will be supplied at
every efficient allocation:

Q5) Ann(A) and Bobby(B) share an apartment. They spend some of

their income on private goods separately and some of their incomes on pub-
1 3
lic good like TV. A’s utilty function is :UA (XA , G) = G 4 X 4 , and B’s utility
1 1
function is :UB (XB , G) = G 2 X 2
where XA and XB are the quantities of private good consumed and G is the
size of public good, where ,G = gA + gB , the contribution of A and B for
buying TV. Both Ann and Bobby have income of Rs2000 each per month.
Price of public good id given by PG = 100 and price of private good is given
as , PX=1.PG reflects the marginal cost of public good.
1)Write the condition for the provision of the Pareto efficient amount of pub-
lic good assuming both A and B can pool their resources.
2) Find the optimum size of G for the provision of the public good assumingXA =
XB .

Q6)If the utility possibility frontier is linear

UA + 2UB = 400
and social welfare is maximized at the corner point, namely at UB = 200,
which of these cannot be the social welfare function? Draw a diagram to
explain your answer.
1) W = UB + 2UA
2)W = UA + 2UB
3) W = UA UB
4)W = UB + UA

Q7)There are two agents and each agent has utility Ui (G, Xi ) where Xi
is private consumption and G is the size of public good.
G = g1 + g2
where gi is agent i’s contribution on the public good. The price of private
consumption is Px and prive of public good is PG .Each agent has an income
Mi and thus an individuals budget constraint is
Px Xi + PG gi = Mi
Let the utility function of the two agents be,
U1 = 300lnG + X1 and

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U2 = 200lnG + X2
The income of the two agents M1 andM2 is given as 1000 each. PG is given
as 1:
1) Write an equation that expresses the condition for the provision of the
Pareto efficient level of public good and find the value of G.
2) Find the amount each person spends on private good, if each person shares
the cost of public good equally.
Do you think an increase in income of both persons will increase the amount
of public good provided? Give reason for your answer.